Absorption Costing Methods & Examples

Aren't you excited to journey deeper into the realm of accounting? Today's topic is absorption costing. Who wouldn't want to explore this land's two major kingdoms, known to the common man as process costing and job order costing? Grab your best hiking stick, friend; it's quite a journey.

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What, There's More?

Oh c'mon now, it's not that bad, promise. The absorption method has two main systems. These are called process costing and job costing. Process costing, as explained in Understanding Absorption Costing, is a system most often used to tally the costs associated with producing like units. Basically, if you were to walk into a warehouse, you would not be able to differentiate one unit from the next. Examples include Hoover vacuum bags, Coco Cola, aluminum foil, Saran wrap, and so on.

On the other hand, job costing is a system used to tally the production costs when several different types of units are produced. Examples include clothing, which comes in all shapes, sizes and colors. Think about companies that produce greetings cards or pottery. And of course, remember your friendly neighborhood accountant and her sidekick, the lawyer. Well, we haven't decided if the lawyer is the sidekick or the villain yet, but that's a topic for another day. For now, we'll stick to our two main forms of traditional costing methods. Process costing and job order costing are similar in that they both seek to assign labor, material, and manufacturing overhead costs to products to determine the cost per unit.

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Process Costing

The most basic formula used to determine unit product cost in process costing is:

unit product cost = total manufacturing cost / total units produced

However, process costing is much more complicated than this simple formula. One needs to understand the flow of materials, labor, and overhead as the unit product moves through the production line. Terms such as equivalent units of production, conversion costs, and weighted-average method require exploration. For now, suffice it to say that assigning costs using the process costing system is a method used commonly by manufacturers producing uniform (the same) products over long periods of time.

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Job Order Costing

Most likely, job order costing is the system that the majority of people are familiar with. Job order costing utilizes several forms. These include:

The Materials Requisition Form - used by the production department to record the raw materials that will be taken from inventory to work on the order. It also specifies the job that the cost of these materials will be charged to.

The Job Cost Sheet - This form is usually prepared by the accounting department and will note the labor, materials, and overhead costs that will be charged to the job. It's usually prepared after the accounting department receives the Materials Requisition Form.

A Time Ticket - Form used to record direct labor. However, more and more manufacturers, even smaller companies, are switching to more automated forms of tracking time. These include hand punch clocks, retinal scan clocks (yes, they have them) and even the internet. Rarely are the old punch cards used nowadays.

In job costing, your friendly neighborhood accountant also needs to figure calculations such as a predetermined overhead rate, which is used to allocate manufacturing overhead across the different jobs. Remember that manufacturing overhead is an indirect cost. It includes expenses such as factory utilities, factory rent, and raw materials like glue. Glue is a good example of a raw material that is used on more than one type of product.

There you have it, a brief tour of two kingdoms and the exhilaration that goes with any adventure into the unknown.